Applied Rationality focuses on public policy issues and tries to take a liberal perspective that is consistent (comments to the posts will often show otherwise) with neoclassical, rational-choice economics.

Wednesday, October 19, 2011

Will BofA lose money over its $5 debit card fee?

In introductory economics, we teach that when the price of a product goes up, the demand for that specific product goes down. When Bank of America (BofA) announced its new $5 debit card fee for certain types of accounts and effectively raised the price on those accounts, those well-known economic laws kicked in, though possibly to BofA's advantage.

This morning's Charlotte Observer reports on the predictable and intuitive result--customers are leaving BofA for credit unions.

Charlotte-area credit unions have seen an increase in phone calls and new members in the last two weeks as people upset about new fees at big banks look for new places to park their money.

Several credit unions have launched advertising campaigns promoting their fee-free offerings, hoping to capitalize on the wave of consumer discontent since Bank of America announced its $5 monthly debit card fee late last month.

"It's been wonderful," said Nicol Morris, chief operating officer of the Charlotte Metro Federal Credit Union, which has about 33,000 members.

She said the credit union saw a 350 percent increase in online account creation, along with a 90 percent increase in calls.

"They are extremely fed up with the continued talk about fees, whether it's in regard to checking or the debit card fee," she said.

The loss of customers is undoubtedly bad news for BofA and surely must have been anticipated by its management.

Nevertheless, the new fee might still improve BofA's bottom line and leave BofA laughing all the way to, well, um, itself.

Some of the other things that we teach in introductory economics is that the sizes of the responses matter and that you have to consider all of the responses.

To the first point, the loss of customers might not be that large--that is, the demand response might be inelastic. Some simple, completely made-up numbers can help to illustrate. Suppose that the new fee adds 20 percent to BofA's revenues from the average basic checking account but that the new fee also causes 10 percent of the accounts to close. In this (made-up) example, BofA's total revenues on basic accounts go up by 8 percent (it gets 20 percent more revenue on the 90 percent of accounts that stay with the bank but loses 10 percent of its initial revenue from the accounts that close).

With respect to the sum of responses, BofA appears to be steering its existing basic-service customers toward other more-profitable services. From another article in the Charlotte Observer

Bank of America CEO Brian Moynihan said Tuesday that a recently announced $5 monthly debit-card fee is a way to encourage people to bring more of their "banking relationships" to the Charlotte-based bank.

The comments were among Moynihan's first responses to the debit-card fee, which has drawn a significant outcry from consumers and politicians since it was announced late last month.

"When we look at the profile of customers who have their entire banking relationship with us and those that don't, a lot of people can qualify, will qualify and do qualify not to pay the fees...," Moynihan said on a conference call with analysts to discuss the bank's quarterly earnings report.

"The issue is when people split their relationship and use our convenience and our access and our 18,000 ATMs ... and our online banking products and all that and yet have their relationship elsewhere," he said.

"That is tough for us to afford to provide and... be competitive. And so the fees are to get people to bring more of their relationships, and we're comfortable that we'll end up in a good dynamic there."

Debit-card users will not have to pay a fee if they have at least $5,000 in a linked savings account, a mortgage or a substantial investment account with Bank of America.

The new fee will cause some people to substitute away from basic services toward other BofA services. Also, BofA's creepy "relationship" language is telling.

The "relationships" themselves not only represent additional streams of revenues but also represent ways of reducing future demand responses. It turns out that breaking up is hard to do, especially when those "relationships" are with your bank.

Each "relationship" that BofA establishes with its customers, is one additional "relationship" that would have to be terminated in order to leave for another bank or credit union. If a customer has set up automatic deposits and automatic bill-paying, he or she would need to go through the hassle of changing each of these "relationships" before leaving for good. Instead of one change in service, there would now be multiple changes. People aren't formally locked into an account. However, it becomes much harder to leave, especially given people's predisposition toward behavioral inertia.

In the end, the sizes of these responses--the loss of customers versus the gain of per-customer revenues and the tie-in effects--will determine whether BofA comes out ahead. At this point, it would be premature to count BofA out, and you better believe that other banks (and geeky economists) are watching carefully.